IRS AFR Rules for Intra-Family Mortgages and Seller Financing:

 

How Applicable Federal Rates Affect Family Home Loans and Seller-Financed Sales

 

By Timothy Burke, National Family Mortgage ®
For informational purposes only; not tax or legal advice.

 

Executive Summary

When families finance home purchases privately–either through intra-family mortgages or seller-financed transactions–the Internal Revenue Code imposes specific rules governing minimum interest rates. These rules are commonly evaluated by reference to Applicable Federal Rates (AFRs).

AFRs do not determine whether a family loan or seller-financed sale is permitted. Instead, they function as benchmarks used by the IRS to evaluate whether stated interest is adequate for tax purposes. When interest is charged below required levels, the transaction may be treated as a below-market loan, potentially triggering imputed interest or unintended gift characterization, even when repayment is expected.

These minimum-rate concepts come from the tax code’s adequate stated interest framework (e.g., IRC §1274 and the below-market loan rules in IRC §7872).

This article explains how AFR rules apply to common family home-financing arrangements and how families can structure and document transactions in a way that aligns with federal expectations.

About This Topic

Intra-family mortgages involve tax rules, legal structure, and documentation details that are often more nuanced than traditional bank financing. This article explores those considerations in depth so families and advisors who want to understand why certain rules exist — and how they apply — have clear context.

In practice, National Family Mortgage simplifies these concepts into a clear, structured process for eligible families. How these principles are implemented — including loan documents, eligibility, and best practices — is defined by our Guides.

 

What Are Applicable Federal Rates (AFRs)?

Applicable Federal Rates (“AFRs”) are interest rates published monthly by the Internal Revenue Service and referenced in the tax code as benchmarks for evaluating whether stated loan interest is adequate for federal tax purposes.

AFRs are used in a wide range of contexts, including:

  • Intra-family loans

  • Seller-financed real estate transactions

  • Below-market loan analysis

  • Imputed interest calculations

For family home-financing arrangements, AFRs provide a reference point, not a guarantee of treatment.

 

Why AFRs Matter in Family Home Financing

AFRs matter because the tax code distinguishes between:

  • Loans with adequate stated interest, and

  • Below-market loans, which may trigger imputed interest and gift-related consequences

When interest is charged below required benchmarks–or not charged at all–the IRS may treat part of the transaction as something other than debt, regardless of the family’s intentions.

This analysis applies equally to:

  • Parents lending money to children to buy a home

  • Other relatives lending funds secured by residential property

  • Seller-financed home sales between family members

 

AFRs and Intra-Family Mortgages

Intra-family mortgage basics

An intra-family mortgage typically involves:

  • A family member lending funds

  • A written promissory note

  • The loan being secured by a residence

  • Repayment over time under stated terms

From a tax perspective, the IRS evaluates whether the arrangement reflects bona fide debt, including whether interest is stated at an adequate rate.

Role of AFRs

Using an AFR-based interest rate is a common method for structuring an intra-family mortgage in a way that aligns with federal expectations regarding interest adequacy.

Charging interest below AFR benchmarks increases the risk of:

  • Below-market loan treatment

  • Imputed interest being attributed to the lender

  • Potential gift characterization

AFRs address interest adequacy only. They do not replace the need for proper documentation, repayment behavior, or a realistic expectation of enforcement.

 

AFRs and Seller-Financed Family Home Sales

What is seller financing?

In a seller-financed transaction, the seller allows the buyer to pay some or all of the purchase price over time, typically evidenced by:

  • A promissory note

  • A recorded mortgage or deed of trust

  • Stated interest and repayment terms

When seller financing occurs between related parties, AFR considerations still apply.

Interest adequacy in seller financing

Seller-financed obligations are evaluated similarly to loans for purposes of interest adequacy. If stated interest is below required benchmarks, the transaction may be treated as partially below-market, with tax consequences that differ from what the parties intended.

AFR-based rates are commonly used to demonstrate that stated interest reflects an objective, federally recognized benchmark.

 

Below-Market Loans and Imputed Interest

What happens when interest is too low?

When a loan or seller-financed obligation charges interest below required levels, the tax code may impute interest that is treated as:

  • Paid by the borrower, and

  • Received by the lender

This imputed interest can result in:

  • Taxable income to the lender

  • Deemed transfers of value between family members

  • Additional reporting complexity

These consequences apply even when no cash interest is actually paid.

 

Choosing an AFR Term and Loan Structure

AFRs vary based on:

  • Loan term length

  • Compounding assumptions

  • Timing of rate selection

The appropriate AFR depends on the structure of the transaction, including maturity and repayment schedule. Selecting and documenting the applicable AFR at the outset helps reduce ambiguity later.

Families should clearly document:

  • Which AFR applies

  • When the rate was selected

  • How the selected rate relates to the stated loan terms

 

AFRs Address Interest — Not the Entire Analysis

Charging an AFR-based interest rate addresses interest adequacy, but interest alone does not determine whether a family loan or seller-financed obligation will be respected.

Other factors remain critical, including:

  • Written documentation

  • Clear repayment terms

  • Consistent payment behavior

  • A realistic expectation of repayment

  • Conduct consistent with those expectations

A transaction that charges adequate interest but lacks clarity or consistency may still face scrutiny.

For a borrower profile where employment type complicates qualification, see Intra-Family Mortgages for Self-Employed Borrowers.

 

Practical Considerations for Families

When using AFRs in family home financing:

  • Address interest terms before funds change hands

  • Document rate selection and loan terms clearly

  • Align payment behavior with the stated schedule

  • Treat modifications and forgiveness as separate, documented decisions

AFRs are a tool for compliance, not a substitute for structure.

 

Frequently Asked Questions

Are AFRs required for every family loan?
AFRs are commonly used to evaluate interest adequacy for tax purposes, but their application depends on the structure and facts of the transaction.

Do AFRs apply to seller-financed family home sales?
Yes. Seller-financed obligations are subject to similar interest-adequacy analysis when they involve related parties.

Can a family loan charge interest above AFRs?
Yes. AFRs function as minimum benchmarks, not maximum rates.

What happens if AFRs change after the loan is made?
Interest adequacy is generally evaluated based on the rates in effect when the loan is established, not on later rate changes.

 

Technical Appendix

Key concepts
Applicable Federal Rates
Below-market loan rules
Imputed interest
Bona fide debt analysis

Analytical framework
Interest adequacy
Documentation and conduct
Expectation of repayment and enforcement

 

About the Author

Timothy Burke is the founder of National Family Mortgage ®, an online company focused on helping families document and support compliant intra-family mortgage loans and seller-financed home transactions. His work focuses on proper documentation, alignment with applicable federal tax rules, and practical implementation considerations for families and their professional advisors navigating private family financing.

Families and their advisors should consult applicable statutes, regulations, case law, and professional guidance when applying these principles to specific transactions.

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